Every week, a leading fund manager or expert at making money grow explains why
savers and investors should see things their way. This week, Guy Foster of
Brewin Dolphin looks at ways to avoid being dragged down by the weak pound.

The recession has started and the outlook is challenging. Many uncertainties remain; however, asset managers and strategists have identified corporate bonds as the overwhelmingly favoured asset class for 2009.

This seems a logical bet as credit spreads (the extra income which a bond will pay to compensate you for taking the risk that the issuer won't pay) are at historically high levels; often now likened to those prevalent during the Great Depression. This view has helped our favoured M&G Corporate Bond Fund receive new funds of close to £300m during December.

Somewhat perversely, those same asset managers and strategists have identified government bonds as being the least favoured asset class. For government bonds to lose their lustre, investors would expect a marked rise in expectations of future interest rates or inflation, both of which would, in normal circumstances, impact corporate bonds negatively. In fact any weakness shown by government bonds should be a headwind for corporate bonds.

But the rising inflationary expectations which worry government bond bears are not unfounded. Although we expect the UK to experience some form of benign deflation this year, the risks of it becoming malignant have been tempered by the unprecedented responses of both the authorities and financial markets.

The authorities have slashed interest rates and accelerated fiscal programmes, not just in the UK but worldwide. The US, UK and even European authorities have signalled their willingness to use all the powers at their disposal to reinflate economies.

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At the moment this monetary stimulus is being soaked up by the gaping holes in our banks' balance sheets, making it difficult to estimate how much more is needed. The task is akin to filling a bottle with water; once it becomes full the flow needs to be stemmed rapidly to prevent it gushing forth uncontrollably.

This overflow would be inflation, the ultimate villain that seeks to destroy our wealth. Inflation means our money is worth less and we need more of it to do simple things like fill our cars with petrol, clothe our families and buy a beer on holiday.

The financial markets have done their bit to wrestle the UK from the jaws of deflation. The 30pc fall in sterling versus its trading partners increases the costs of goods bought from overseas (or holidays taken abroad). In effect, we are importing inflation and this price instability, while a threat to our holiday plans, is an opportunity to investors.

If inflation does reappear and sterling continues to fall then cash in a UK bank will lose value in "real" terms. That is to say, you won't be able to buy as much with your money in the future as you can now. By contrast, inflation-protected securities or those in other currencies can improve your real wealth.

Our asset allocation team's recommendation to increase overseas exposure has been judicious over the past year and is one we expect to retain despite the adjustment in sterling. While the dollar, euro and yen all have weaknesses, it is only sterling that is characterised by having so little to support it.

The relationship between currency depreciation and rising inflation is tight. Either can lead the other and at this time we therefore retain a bias towards overseas assets and look for additional ways to protect portfolios against inflation.

One way to add protection is index-linked bonds. In November last year there was an extreme undervaluation of index-linked bonds in the UK and the US. It was, and still remains, a theme that investors should look to play through the likes of bond funds.

One such fund is the Thames River Global Bond Fund, which has benefited from the rise in conventional bonds but has also introduced a weighting in US index linked bonds (TIPS) at around the same time as investors were buying their UK equivalents.

Overseas equity income is also worth a look. As income from UK equities has continued to fall, so overseas equity income has looked attractive. Overseas sources of income such as government and corporate bonds are yielding more than their UK counterparts; however, it is equity exposure which, at present, holds interest for investors.

A yield gap (when equities yield more than bonds) has now emerged in most developed markets which indicates that equities are potentially undervalued (notwithstanding the likelihood that dividends will be cut to some extent).

Additionally, the best time to buy equities is characterised by a sense of anxiety at doing so. Therefore, holdings in funds such as Newton Asian Income, Ignis Argonaut European Income and JPM US Equity Income should provide useful and regular dividends which are diversified away from sterling.

Combining these with index linked, conventional and corporate bonds should allow an investor to benefit from the volatility and price instability of the future.